UBS Road to the Election: Banks and the race(10:18)

Listen in to CIO's Bradley Ball on how the November US election outcome could affect the banking sector.

Thought of the day

Markets have encountered headwinds at the start of the US earnings season, amid heightened geopolitical risks, higher US bond yields, and worries about the outlook for chipmakers. The S&P 500 Index fell 3.1% last week, its worst performance since March last year. The tech-heavy Nasdaq slid 5.4%, the largest weekly decline since November 2022. Within the market, AI chipmaker NVIDIA declined 13.6% over the week. That followed a drop in orders at ASML Holding, which produces the equipment needed to make the most advanced microchips, raising concerns over weaker demand from other global chipmakers.

But, without taking single-stock views and looking more generally at global equities, we think investor pessimism may be both premature and overdone:

The outlook for AI chip demand remains positive. Without taking a view on individual stocks, ASML’s miss on first-quarter orders was largely due to one customer delaying its purchases amid pricing negotiations. It should only be a matter of time before orders return, in our view, as AI chip production globally continues to scale up. Separately, the tech correction led by some of the most high-profile chip US companies on Friday appeared to be largely driven by technical factors, with monthly option expiries adding to the selling pressure. In fact, recent results suggest that AI chip demand overall remains strong and growing. While we shall closely monitor this week’s earnings for additional details on AI monetization and capital expenditure trends, we maintain a positive view on the theme, and continue to favor the semiconductor and software segments.

Other early results remain consistent with our expectations for healthy US earnings growth of 7–9% for the quarter. While only 15% of the S&P 500 market capitalization has reported so far, nearly 60% of companies are beating sales estimates and 75% are beating earnings estimates. In aggregate, earnings are beating by roughly 9%, better than our expectations for a beat rate of between 4 and 6%. Guidance has also been encouraging. The second-quarter earnings per share estimate (EPS) for the companies that have reported is holding up better than normal. And we see signs that this earnings growth is likely to expand beyond the largest technology companies, auguring well for a broadening in better corporate fundamentals and potentially elevating some investor concerns about concentration risks.

A market retreat was not unexpected, given the extended nature of market positioning and bullish sentiment coming into the second quarter. At the end of March, the S&P 500 recorded an all-time high, which capped off a six-month return that was among the highest in the past eight decades. This lifted valuation, sentiment, and positioning indicators to elevated levels, in our estimation. Since then, a strong March jobs report and hotter-than-expected US inflation prints have pushed out Federal Reserve rate-cut expectations and driven a more than 40-basis-point increase in the 10-year US Treasury yield in a matter of weeks. History shows that rapid increases in interest rates over short periods of time typically weigh on stocks. Yet, our view remains that the slowing of US inflation will resume, allowing markets to focus on a likely pair of US rate cuts in 2024, with the first most probable in September.

So, while further volatility can be expected, especially with ongoing attacks in the Middle East, we think a gradually improving risk-reward outlook for US stocks continues to support our focuses on finding opportunities within and beyond technology. Ahead of another busy reporting schedule this week, we maintain our year-end S&P 500 price target of 5,200, underpinned by a solid estimated 9% earnings growth, still-cooling inflation, two expected Fed rate cuts, and continued robust corporate investment in AI. We continue to favor quality stocks as well as AI beneficiaries, with potential to use structured strategies for exposure to potential gains while limiting losses in the event of further consolidation. We also see ways investors can diversify their stock exposure beyond tech, including in US small-cap stocks that should benefit from the broadening earnings trend identified above and still-compelling relative valuations versus US large-cap stocks.